market folly

BNI: Buy, Target Price: $110, Time Frame: 6 months

In recent weeks, we have seen a clear shift in energy prices. Oil has primarily moved upwards due to fundamental reasons (weak US dollar). Oil is cruising higher. And, if you believe in T. Boone Pickens Peak Oil Theory, then the rails are just the play for you. Wait, but if energy prices are high, why would we look to transportation? Don't they get hit hard by these high costs? That's exactly the point. This will affect every single type of transport company (rails, trucks, planes). Rails, however, will be affected the least. We recently saw weak earnings results from trucking companies who cited slowing demand and rising fuel costs. This is all the more reason to be bullish on rails. If it becomes so expensive to ship things via trucks and planes due to high fuel costs, where will suppliers turn? To the rails, of course. Sure, the rails still have to face energy costs. However, the severity of the impact of energy prices on rails is much less than that of trucking companies or planes. It seems that transport has shifted from airplanes and trucks to good old-fashioned railroads. And, to sweeten the deal, this favors rails for the long term as well. As oil is consumed heavily all over the world on a daily basis, Peak Oil Theory will only become that much more evident. This means that airplanes and trucks will become that much more expensive to operate, and the rails will continue to see a shift in their favor. Buffett is undoubtedly playing the rails for the long-term, and he has the perfect thesis to back up his investment: Peak Oil Theory. Not to mention, the rails are the form of transport for some of the hottest commodities out there right now: soft commodities/agriculture. These crops are rising in price due to strong demand and weak supply. The rails are the principal form of transport and this secular bull market spills over right into the rails.

Since we know the fundamental story behind the industry, lets make it easy and invest in the name that Buffett keeps piling into whenever it dips down low: BNI. Fundamentally, BNI offers a compelling story and its clear why Buffett initially made his investment. Besides having strong fundamentals in the underlying sector, this specific company is strong fundamentally as well. With a trailing PE of 19 and a forward PE of 14, BNI has become slightly rich in valuation over the past few months. But, this is due to the fact that they are seeing industry strength which allows them to trade at a higher multiple. With a PEG around 1.19, there is still room for earnings growth as well. Price to sales ratio of 2.19 deems BNI undervalued as any PS of under 5 is very bullish in terms of valuation. Additionally, BNI has a price to book of 3.1 which is decent, but nothing spectacular (it was much cheaper when Buffett first got in, that's for sure). BNI cleans up compared to other rails in terms of operating margins and returns on equity. Every little edge counts and with operating margins of 22% and a return on equity of 16.8%, BNI comes in slightly ahead of its competitors in the "bread and butter" of profitability in their business. Additionally, they are seeing 9.4% quarterly revenue growth. And, that is in the rails? think about that. Such an old fashioned form of transportation is seeing slow and steady growth at this day and age is almost amazing. It all boils down to the underlying sector strength due to the commodity bull market and secular growth in agriculture. There is a negative associated with BNI and that would be their debt. They have $330 million in cash, but more than $8 billion in debt. Seeing as they are raking in the profits, look for them to spend some of that cash to pay down some debt to get their debt/equity level to more comfortable levels.


This piece merely serves to reiterate which name is the best of the pack. BNI recently reported better than expected quarterly profit. In recent quarters, the company cited increased volume from the agricultural business. This fact also benefits BNI as agriculture is seen to continue to be strong through 2008. In my recent analyses of agriculture giants Potash (POT), Mosaic (MOS), and Agrium (MOS) I cited how top management saw agricultural demand as very strong throughout 2008. With energy prices so high, suppliers and farmers will continue to send and receive products by rail. This agricultural bull market adds yet another positive catalyst for BNI and the rail stocks. So now we've got high oil prices and an agricultural bull market working in favor of the rails. The long-term outlook for these names is definitely bright.

Institutional Ownership: As an investor or a potential investor, you like to see this kind of positive outlook, but you also look for reassurance that other great minds are thinking the way you are. And, as a matter of fact, BNI's shareholders include some of the great names in terms of investors. First off, as mentioned earlier, Warren Buffett has recently acquired stakes in BNI and UNP, betting big on rails for the long term. Buffett's Berkshire Hathaway has taken a greater than 16% stake in BNI, and it is one of Berkshire's largest investments in a long time. His vote of confidence in these names alone should give other investors even more confidence. Secondly, besides receiving a seal of approval from Warren Buffett himself, BNI has also received a stamp of approval from one of the most successful and well respected hedge funds on Wall Street: Atticus Capital. 3% of Atticus' portfolio resides in shares of BNI. Now, some of you might be thinking, 3%?! That's not that impressive. Well, it immediately becomes impressive when you find out that Atticus is a $13 Billion Hedge Fund. 3% of $13 Billion? You do the math. Lastly, BNI also has seen BlackStone take a heavy stake in their company through their Kailix Advisors Hedge Fund arm of their organization. 5.1% of Blackstone's hedge fund portfolio is secured in shares of BNI. As you can see, 3 major names in the world of Wall Street have bet on BNI and the rails for the long term. Not to mention, they have bet with very large amounts of money. When you have this many smart minds investing in one name, it's definitely worth checking out. Collectively, they've done more research than all of us could do combined. If there ever was a vote of confidence in a stock, this is it. This provides just an additional reason to like BNI. With Buffett, Atticus, and BlackStone all backing this name, it's hard to bet against them.

BNI: Buy, Target Price: $110, Time Frame: 6 months